Ethena’s USDe is unlikely to collapse, but as the market grows, there may be a situation where USDe yields approach zero due to marginal effects.
Table of Contents:
The Issuance Logic of USDe
Collateral and Liquidation of USDe
Risk Hedging of USDe
Risks and Bottlenecks of USDe
Exchange Risks
Systemic Risks of Lido
Ethena as an Obstacle to Market Growth
Conclusion
Ethena has been a star product recently, attracting significant attention with its initial release of ENA on Binance and its stablecoin USDe. Even though the market sentiment is currently low, Ethena’s Total Value Locked (TVL) is still around $2.4 billion.
Many people associate token collateralized stablecoin issuance with high-yield products, and the first thing that comes to mind is Terra’s UST algorithmic stablecoin. From 2021 to 2022, UST attracted nearly $10 billion TVL with a 20% annual yield. However, it eventually collapsed along with Terra Luna.
Many readers may have doubts, concerns, or suspicions that Ethena is another imitation of UST and may collapse. But I want to give a conclusion here:
Although USDe, like UST, is collateralized with mainstream cryptocurrencies and issued at a face value of $1, their fund operation logics are completely different.
UST’s fund operation is straightforward: users collateralize the value of cryptocurrencies and receive an equivalent amount of UST. However, the key point is that UST is deeply tied to Luna. The higher the market demand for UST, the more deflationary pressure it puts on Luna, driving up its price. And the higher the price of Luna, the more UST can be minted.
Therefore, the essence of UST’s fund operation is to create value by constantly increasing its virtual market value. With the increase in Luna issuance, an almost infinite supply of UST appeared in the market, leading to the collapse of this multi-billion-dollar fund.
On the other hand, USDe has a more complex fund operation.
Firstly, although USDe is collateralized with mainstream cryptocurrencies, it currently does not accept direct deposits of ETH or BTC from regular users. It only allows the purchase of USDe through a range of stablecoin assets (USDT, USDC, DAI, etc.). This means there is no liquidation risk for regular users.
For whitelisted users (usually institutions, exchanges, and whales), they can deposit LST assets, specifically stETH, to mint USDe. Therefore, whitelisted users bear the risk of liquidation. However, since Ethena hedges this risk, they only need to bear the price difference risk between ETH/stETH, and Ethena predicts that this price difference risk will only be triggered when it reaches 65%. The largest historical price difference between ETH/stETH was nearly 8% during the Terra collapse in 2022.
Therefore, under normal operation, this liquidation risk is almost impossible to occur. So we can rephrase it: Ethena will only be liquidated when there is a systemic risk with Lido’s stETH.
Additionally, Ethena’s leverage ratio is close to spot trading. Even if liquidation occurs, it does not mean that Ethena will lose all collateral. It will be liquidated gradually based on the relevant positions.
It is important to note that Ethena is not a decentralized execution product. It is operated by a centralized asset management team 24/7 and has cooperation agreements with major exchanges. Therefore, in official documents, Ethena states that the asset management team will intervene manually to reduce risk when there is a liquidation risk.
Furthermore, after completing the collateralization, Ethena does not simply hold the assets. It adopts a centralized asset management approach, which is counterintuitive to Web3. Regardless of stablecoin assets from regular users or LST assets from whitelisted users, they will be split at a face value of $1 and then undergo two operations: holding spot ETH in the form of stETH and opening ETH short positions in partner exchanges. This leads to the following value equation:
Therefore, when Ethereum rises, the profit from the increase in spot ETH will offset the loss from the ETH short position. When Ethereum falls, the profit from the ETH short position will offset the loss from spot ETH. Ultimately, USDe maintains a stable value at $1.
Additionally, Ethena relies entirely on centralized exchanges for risk hedging. It currently collaborates with more than ten exchanges, including Binance, OKX, Bybit, and Bitget. Therefore, Ethena avoids Web3 hacking attacks in terms of fund security, and it has obtained liquidity far beyond decentralized exchanges and lower transaction fees.
The Sources of USDe’s Yield
USDe’s yield comes from two sources:
1. Rewards from staking assets
2. Funding fees and basis gained from risk hedging
The rewards from staking assets are easy to understand, which are the consensus rewards obtained from staking ETH. Currently, Ethena guarantees the yield by holding stETH, with an annualized interest rate of approximately 3%.
The more noteworthy source is the gains from risk hedging. The basis is a well-known concept of futures arbitrage, and funding fees are the fees paid by long and short positions to each other based on market advantages.
According to Ethena’s calculations, the annualized yield from futures arbitrage in 2021 was 18%, -0.6% in 2022, 7% in 2023, and 18% from 2024 to the present. Although the annual market conditions vary, the long-term average yield is above 10%.
The funding fees, on the other hand, depend on the market’s bullish or bearish conditions. When Bitcoin was trading above $70,000 last month, Binance’s funding fee reached 0.1%, which directly pushed the yield of sUSDe to 30%.
However, there is a crucial point here. Ethena’s hedging strategy relies on shorting ETH, which means that it incurs short fees when the market weakens. Therefore, Ethena may experience a period of time during a bear market when the yield of sUSDe approaches zero.
Nevertheless, a more optimistic view is that Ethena’s historical data testing reveals that both ETH and BTC perpetual futures had negative yields for 19.1% and 16.1% of the days, respectively. The average yield for ETH during the period was 8.79%, and for BTC, it was 7.63%.
The most extreme case was in 2022 when Ethereum faced a hard fork arbitrage, resulting in a negative average yield for the quarter.
Therefore, from an annual perspective, Ethena’s executed strategy is indeed profitable in the long run. However, it goes against the nature of the cryptocurrency market. Cryptocurrency players often use stablecoins for wealth management during bear markets and withdraw stablecoins for aggressive trading during bull markets. Ethena’s yield fluctuation curve is the opposite. It has a high yield during bull markets and a low yield during bear markets.
Although Ethena seems to be a well-designed product in theory and considers various risk controls, there are still some potential black swan risks that I believe are not far off.
Currently, Ethena’s risk hedging strategy relies entirely on centralized exchanges for execution, and exchanges themselves pose a risk. Daily incidents such as system crashes or network disconnections can amplify price spreads, but these can be resolved through compensation or rollbacks. What cannot be solved are policy and systemic risks.
The United States’ regulation of cryptocurrency exchanges is becoming stricter. Binance’s CZ was involved in mining pledging, and various exchanges have been sued by the SEC. Moreover, there is a possibility of another FTX-like collapse that could result in huge losses for Ethena. These are black swan risks.
Lido, as the leader in the Ethereum LST field, has not experienced major security incidents so far. However, once it happens, it will not only affect Ethena’s collateral but also severely impact the Ethereum ecosystem. Let’s not forget that a few years ago, before the Ethereum PoS upgrade, stETH experienced significant anchoring issues.
There is a joke in the crypto industry: playing short contracts is like shorting your own business. Indeed, this is what Ethena does.
This data dashboard is from Ethena, showing that the market has $8.6 billion in open ETH contracts, and Ethena’s position accounts for 13.52%, which is $1.162 billion. It is also worth noting that 86% of the $8.6 billion contract market includes positions from both long and short sides. Even if we assume an equal distribution between long and short positions, the short funds should be around $4.3 billion. However, Ethena only takes short positions in the contract market, which means that it occupies 27% of the entire ETH short position funds.
And this is only after a few months of Ethena’s launch and during a period of low market sentiment. Once the market enters an upward cycle and Ethena’s yield starts to rise, more funds will inevitably flow into Ethena, resulting in a larger short position. As Ethena’s short position increases, the funding fees to be paid during market downturns will also increase, resulting in a marginal effect where the yield approaches zero.
In conclusion, Ethena is indeed a well-designed product, but it is not DeFi, nor is it a sidekick like UST. If I were to describe it accurately, Ethena is a fund product based on cryptocurrencies.
It incorporates traditional risk hedging strategies into the world of cryptocurrencies and captures returns from more volatile market conditions. Additionally, due to the permissionless nature of blockchain, anyone can purchase this fund product without going through KYC/AML procedures.
Related Reports:
Ethena Integrates Binance, Bybit, OKX, and Bitget Web3 Wallets! Locking in USDe Bonus Rewards, $ENA Breaks $1.5
$ENA Surges to $1.4, Setting New High! Ethena Introduces New Incentives, Whales Invest $8 Million, USDe Market Cap Exceeds $2.2 Billion
In-Depth Analysis of Ethena: Why Can USDe Provide the Highest Stablecoin Returns and What Are the Hidden Risks?